Philippines: A Nice Place To Visit, But I Wouldn't Want To Invest There

| About: iShares MSCI (EPHE)

Summary

The Philippines is one of the fastest-expanding countries in the world this. Growth is expected to ease but remain relatively strong until 2018.

The automotive industry, electronics, and BPO are expected to grow in 2017. Mining output should fall due to nickel mine closures.

The Philippines' investment-to-GDP ratio currently stands at 19.7%, considered a low level of investment that will inhibit business growth.

Corruption and cronyism are rife in business and government. A few dozen families hold much of the land, corporate wealth, and political power.

The stock chart for EPHE is uninspiring. Despite the high rate of GDP growth over several years, the ETF has not performed. I can make no recommendation to buy EPHE.

The iShares MSCI Philippines ETF (NYSEARCA:EPHE) provides exposure to a broad range of companies located in the Philippines. The Philippines' population is spread across 7,000 islands in the Western Pacific, and its residents speak more than 80 languages and dialects. As a newly industrialized country, the Philippines has an economy transitioning from one based on agriculture to one based more on services and manufacturing.

The Philippines is one of the fastest-expanding countries in the world, with a GDP growth of 6.8% in 2016. The economic growth is expected to moderate slightly but remain relatively strong until at least until 2018, underpinned by a $160 billion-infrastructure plan aimed at creating jobs.

According to Rahul Bajoria, a senior economist at Barclays Plc in Singapore:

Philippines will remain an outperformer in the region. It is domestically driven, with consumption holding up quite well and the fiscal spending being planned. The global risks we're seeing including to trade won't fundamentally alter its prospects.

Figure 1 - Philippine GDP growth (Source: bloomberg.com)

The Philippine economy is grouped in a second tier of emerging markets, called the Tiger Cub Economies. The Tiger Cubs are five newly industrialized countries in Southeast Asia: Indonesia, Malaysia, the Philippines, Thailand and Vietnam. They are so named because they are perceived to be young versions of the Four Asian Tigers: Hong Kong, Singapore, South Korea and Taiwan.

Agriculture

Agriculture employs the largest percentage of the Filipino workforce and accounts for approximately 11% of GDP. The Philippines is the world's largest producer of coconuts and pineapples, and is also one of the largest producers of both rice and sugar. Rice is a staple food in most of the country and the Philippines is also one of the world's largest importers of rice.

Shipbuilding and Repair

Being surrounded by waters, the Philippines has abundant natural deep-sea ports ideal for ship production, construction and repair sites. The Philippines is a major player in the global shipbuilding industry, building ships like bulk carriers, container ships and big passenger ferries.

Automotive Industry

There are currently 15 vehicle manufacturers with operating plants in the Philippines including foreign-owned firms such as Toyota (NYSE:TM), Mitsubishi (OTCPK:MMTOF), Honda (NYSE:HMC), Nissan (OTCPK:NSANY) and Isuzu (OTCPK:ISUZY). There are a total of 272 parts and components manufacturers in the country. The industry has an annual capacity of 250,000 units, the automotive industry accounts for approximately 4% of GDP.

Electronics

The electronics industry is the largest contributor to the country's manufacturing sector. Foreign companies investing in the Philippines include Texas Instruments (NYSE:TXN), Toshiba Information Equipment, Inc. (OTCPK:TOSYY), Amkor (NASDAQ:AMKR), HGST (A Western Digital Company (NYSE:WDC)), and Fairchild Semiconductor (Phil.), Inc., Analog Devices (NYSE:ADI), ON Semiconductor (NASDAQ:ON), Cypress (NASDAQ:CY), Maxim (NASDAQ:MXIM), NXP (NASDAQ:NXPI), STMicroelectronics (NYSE:STM), and IMI Electronics.

Mining and Extraction

Philippine nickel, gold, and copper deposits are among the largest in the world. Other mineral resources include limestone, marble, clays, feldspar, rock aggregates, and sand and gravel resources. Mineral resources are quite extensive covering about 30% of total area of the country. Over half of these lands are claimed by various indigenous tribes. At least 350 registered mining companies are operating in the country.

Offshoring and Outsourcing

Business process outsourcing (NYSE:BPO) is regarded as one of the fastest growing industries in the world. The Philippines is the world leader in BPO due to the low operational and labor costs, high proficiency in spoken English, and a highly-educated labor pool. Growth in the BPO industry continues to show significant improvements with an average annual expansion rate of 20%.

Tourism

Tourism is an important sector for the Philippine economy, contributing approximately 8% to the Philippine gross domestic product (GDP).

Remittances

Migrant remittances transferred to families in the Philippines accounts for almost 10% of GDP. Remittances are an important source of income for many Filipino families and raise the standard of living of recipient families. These flows have become the single most important source of foreign exchange to the economy.

Figure 2 - Foreign exchange sources (Source: adb.org)

Economic Outlook

The Philippines has a young population and a large pool of university-educated workers with strong English-language skills. Economic growth is expected to remain strong until at least until 2018, due to the government plan for spending $160 billion on infrastructure. The BPO sector is expected to continue growing rapidly. The automotive and electronics industries are expected to continue expanding, while agriculture should remain stable. The mining industry will take a hit, as the Philippines ordered the closure of 21 nickel mines on Thursday, accounting for approximately 50% of the country's annual output.

Philippine companies are starting to experience sharp cost inflation and higher global commodity prices, aggravated by a weaker peso, causing slower growth in both output and new orders. Continuation of this trend may put manufacturers' profitability at risk.

The Philippines' investment-to-GDP ratio currently stands at 19.7%, considered a low level of investment that will inhibit business growth. By comparison, the investment rate is 33% in Indonesia, 27% in Thailand, and 24% in Malaysia. Economists caution against high expectations as laws on foreign ownership discourage investors in sectors such as mining. The closure of nickel mines does not help.

Currently, the Philippines is one of the Southeast Asian economies least dependent on China, although ties with China are expected to grow over the next several years.

Risks

As with other Southeast Asian countries, corruption and cronyism are rife in business and government. A few dozen families hold much of the land, corporate wealth, and political power. The rule of law is weak as courts are hampered by intimidation, inefficiency, low pay, and corruption.

There may be a deterioration in business sentiment due to President Duterte's war on drugs. Duterte has said he "wanted the Constitution amended to allow Philippine leaders to wield martial law powers without judicial and congressional approval, a move he said is necessary to contain the ongoing 'drug menace' and maintain peace and security in the country."

The American Chamber of Commerce in Manila told Forbes in a statement Tuesday that:

the issue of extrajudicial killings and the drug war is alarming and could possibly harm the optimism of American business to invest in the country…

There could be a risk to growth because of investor sentiment, and investor sentiment has been getting cloudier given the political situation," says Christian de Guzman, vice president and senior credit officer with Moody's in Singapore. "From the foreign investor perspective, you've heard industry bodies and foreign chambers of commerce are concerned about the law and order situation. That can be a hindrance to further foreign investment."

Checking Under the Hood

The sector breakdown of EPHE is shown below.

Figure 3 - EPHE sector breakdown

Financial stocks account for a very substantial portion (46%) of EPHE's holdings. 4 of the 5 top and 5 of the top 10 holdings are from the financial sector.

Figure 4 - EPHE top 10 holdings (Source: ishares.com)

The Philippines financial companies did well throughout the 2008 financial crisis, despite foreign capital outflow. The banks appear to be conservatively run with a low level of non-performing loans.

The stock chart for EPHE is uninspiring. Despite the high rate of GDP growth over several years, the ETF has not performed. This may be a symptom of government corruption and cronyism.

Figure 5 - EPHE stock chart

At present, I cannot recommend investing in EPHE, for the following reasons:

  • Uninspiring stock chart. Investors should wait until the share price rises to at least $43, above the resistance level.
  • High level of cronyism and corruption. A few dozen people control most of the wealth and power.
  • Low level of investment-to-GDP will likely inhibit business growth.
  • Remittances may be sensitive to recessions in foreign countries.

Summary and Conclusions

The Philippines is one of the fastest-expanding countries in the world, with a GDP growth of 6.8% in 2016. The economic growth is expected to moderate slightly but remain relatively strong until 2018.

The automotive industry, electronics, and BPO are expected to grow in 2017. Mining output should fall due to nickel mine closures.

The Philippines' investment-to-GDP ratio currently stands at 19.7%, considered a low level of investment that will inhibit business growth.

Corruption and cronyism are rife in business and government. A few dozen families hold much of the land, corporate wealth, and political power.

The stock chart for EPHE is uninspiring. Despite the high rate of GDP growth over several years, the ETF has not performed. I can make no recommendation to buy EPHE at the present time.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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